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Oil & Gas-focused Master Limited Partnerships (MLPs) boast a consistent and robust performance history, and their future looks bright as well. A recently held National Association of Publicly Traded Partnerships conference provided a positive outlook on this asset class.

The conference concluded that midstream MLPs are expected to generate two-figure distribution growth in the next three to five years. The partnerships having a strong footprint in key U.S. resource plays, or those that are expanding into these regions, hold significant opportunities for cash flow growth. Last year’s 24% increase in institutional ownership adds to the bullishness on this asset class.

What Are MLPs?

MLPs are allowed to hold operations only in certain types of businesses, mostly related to natural resources. A key point to remember here is that while enjoying the tax benefits of an limited partnership, these businesses are also highly liquid, as the units can be easily traded in exchanges. Additionally, these exhibit hybrid financial features (fixed income as well as equity).

Most of these partnerships have been created by companies in the oil and gas industry, as this structure enables them to monetize cash flow-generating infrastructure assets on a tax-efficient basis. The assets that these partnerships own – oil and natural gas pipelines and storage facilities – typically bring in stable fee-based revenues and have limited, if any, direct commodity-price exposure. This enables these MLPs to pay out fairly higher distributions (dividends).

The Right Strategy    

Since these businesses differ structurally from companies, stock picking on the common parameters such as PE ratio or Price/Sales ratio does not work here. For MLPs, factors such as Distributable Cash Flow (DCF), Distribution Growth and Coverage Ratio are the key selection criteria. MLPs are valued based on their ability to generate, maintain and grow cash distributions.

An optimal choice would be one that has not only consistently paid and grown its distribution but also has a distribution coverage ratio greater than 1. The higher the ratio the better it is, as it ensures the safety of the distribution payment. An added advantage would be to focus on MLPs that have a substantial portion of the cash flow coming from fee-based activities. This acts as a cushion against the volatile commodity prices.

3 Energy MLPs to Buy Now

Based on the above strategy, stocks of the following MLPs look pretty good:

Targa Resources Partners LP (NGLS - Snapshot Report)

Headquartered in Houston, TX, this Zacks Rank #1 (Strong Buy) MLP focuses on acquisition, operation and development of midstream assets in the U.S. The partnership recently paid quarterly cash distribution of 76.25 cents, reflecting a year-over-year growth of over 9%. Targa Resources is looking pretty good on the DCF front as well. The partnership has consistently grown its DCF over the past few quarters and has a trailing 12-month (TTM) distribution coverage of 1.26x.

Targa Resources is poised to benefit from the spurring upstream activity owing to the American dream of being energy-independent in the not-so-distant future. The partnership is also investing heavily to optimize its midstream capabilities and boasts impressive revenue growth and robust cash flow from operations. These positives are reflected in the 30% stock appreciation YTD.  

Magellan Midstream Partners, L.P. (MMP - Analyst Report)

This partnership owns and operates a diversified portfolio of energy infrastructure assets that generate stable and recurring fee and tariff-based revenues. It has consistently paid and grown distributions over the past couple of years. The most recent payment of 61.25 cents per unit reflects year-over-year growth of over 20%. In the first-quarter earnings release, Magellan Midstream not only increased its 2014 DCF projection but also stated that its annual cash distribution growth target is on track.  

This Zacks Ranked #2 (Buy) stock has a TTM distribution coverage ratio of 1.62x. Another advantage that Magellan Midstream has over its peers is the absence of a general partner, which may sometimes eat into the partnership’s distributions. The Magellan Midstream stock also has an impressive YTD return of over 31% and with such positives backing it, there may be some more room left here for upside.

Energy Transfer Partners, L.P. (ETP - Analyst Report)

Based in Dallas, TX, this partnership engages primarily in the gathering, processing, storage and transportation of natural gas and has a long history of payouts. The distribution growth that has remained stagnant for the past few years has finally started rolling. The partnership recently paid a quarterly distribution 93.5 cents per unit, marking its third consecutive quarterly hike.

Energy Transfer Partners has a TTM distribution coverage ratio of 1.10x. The partnership expects to add news contracts with improved rates for its interstate and intrastate pipeline systems as well as grow throughput and processing volumes. A Zacks Rank #2 further confirms the potential in Energy Transfer Partners.

Conclusion

The ever-increasing energy demand in the U.S. is leaving no dearth of growth or expansion opportunities for these partnerships. The fact that MLPs often offer a higher yield than other stocks makes them more attractive as investment opportunities. However, as oil and gas prices are inherently volatile, partnerships with low commodity exposure and more fee-based cash flow options are better suited to benefit in the present market scenario.

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